Calculating the rate of return for solar PV panel systems
The decision to install a solar-energy system is, above all else, a financial decision. As such, a critical first step in the planning process is determining whether solar represents a favorable internal rate of return (IRR) for your company. In many cases, a well designed system may have an IRR of 15 to 20 percent. It bears repeating that every capital outlay comes with an opportunity cost. Spending money on a new printing press, for example, means not spending money on a new delivery truck, or funding R&D, or investing in other fixed capital. IRR -- which is, in effect, the discount rate that sets all future cash flows to zero -- enables managers to compare projects using the same metric.
This article briefly outlines the basic variables behind financial analysis of solar-energy systems. For more a more in-depth financial analysis example, including sample cost estimates, fill out oursolar survey or contact us. We'll provide free, one-on-one consultation for your commercial project.
Moving on, a number of factors bear on solar's rate of return:
(1) The retail price of conventional electricity
The per-kWh price that your company pays for electricity is key. The higher the price charged by the utility, the more your company stands to benefit from installing a solar-energy system. This is because solar derives value, first and foremost, by enabling firms and individuals to avoid electricity charges.
Consider a simplified example. Firm A and Firm B each use 10,000 kWh a month. On average, Firm A pays 6 cents/kWh, while Firm B pays 12 cents/kWh. They both the same install solar PV system, which cuts their respective electricity purchases by half. It's clear that Firm B has made the better investment: their monthly savings is $600, while Firm A's monthly savings is $300. In IRR calculations, these savings are recorded as positive cash flows.
It's worth noting that industrial customers generally pay less for electricity than commercial and residential customers. In 1999, for instance, the industrial sector paid an average of 4.4 cents per kWh, while commercial and residential customers paid 7.3 cents/kWh and 8.2 cents/kWh, respectively. As is discussed in greater detail below, higher electricity prices are commonly associated with relatively faster payback periods and relatively higher internal rates of return.
(2) Electricity price inflation
Consistent with the previous section, the financial performance of your solar-energy system will be affected by the rate at which retail electricity prices increase. Since 2000, electricity prices in the U.S. have increased at an annual rate of 2.5 percent, about half a percent above the 1.99 percent average rate of inflation over the same time period. In other words, prices in the electricity market have been going up faster than prices in the broader economy.
What does electricity price inflation mean for your company? Get the basics here. In brief terms, the bottom line is this: if your company's financial and economic planners are convinced that increases in electricity prices will continue to outpace inflation in the broader economy, they'd be wise to support steps that reduce the firm's exposure to electricity purchases. (They'd be wise to do so even if electricity price inflation is the same as broader inflation rates.) Though a range of steps can be taken -- from energy-saving technologies like compact fluorescent light bulbs and LEDs, to cogeneration wood-chip boilers -- we at Getsolar talk about what we know best. And that's solar. Put simply, with an typical lifespan of 25 years, solar-energy systems are an effective means of shielding your company from electricity price inflation over at least two decades.
So, to review: when determining the financial viability of a solar-energy system, future inflation in electricity prices needs to be factored into the equation. The higher the assumed rate of inflation, the quicker the payback and the higher the IRR.
(3) System performance
PV panels work according to the photoelectric effect -- or the photovoltaic effect. The nerdy details go back to scientists like Heinrich Hertz and Albert Einstein, but essentially it goes like this: if you expose a metallic surface to the right frequency of electromagnetic radiation, the metal will eject electrons. The electrons can be collected together in wires and conveyed as electricity.
It so happens that silicon, the most common material used in solar cells, ejects a lot of electrons when exposed to visible light (sunlight). Over time -- say 25 or 30 years -- the silicon loses its spunk, so to speak. As such, it's necessary to account for degradation in system performance on a year-over-year basis. We tend to assume a conservative rate of 0.5 percent per year.
(4) System maintenance
Like any piece of equipment, solar panels require maintenance from time to time. Luckily, solar equipment is pretty rugged and the costs involved are therefore relatively modest. Unless your system uses electronic servos to track the sun (cool technology, but fairly rare), solar-PV systems have no moving parts.
A commonly used cost multiplier is 0.2 percent of total installed costs per year -- a conservative figure. This is enough to keep the PV cells free from dirt and dust, the accumulation of which can reduce system performance. Also, at some point your system will need a replacement inverter. In many cost estimates, you'll typically see this capital expenditure scheduled in Year 15 of the system's expected life.
(5) Government incentives
Currently, solar energy systems are able to achieve cost effectiveness because the federal government -- and many state governments -- sponsor renewable-energy incentive programs. These incentives include tax credits, rebates and grants, as well as provisions for accelerated cost recovery (and a 50% bonus depreciation for systems installed in 2008 and 2009). By lowering upfront costs, incentives can drastically increase the return of a particular system.
All U.S.-based firms can take advantage of the federal programs. But beyond this total project costs will depend on where your company decides to install the system. Some states provide generous incentives, some provide none at all.
Related reading:
IRR and Commercial Solar |
